Investing for multiple outcomes central to successful hedging
We spoke with Stephen Coltman, Investment Manager within the Alternatives team at abrdn on the growing importance of portfolio hedging amid growing uncertainty and investor unrest.
During times of falling equity markets, rising volatility and elevated drawdowns, Coltman is tasked with delivering positive returns. Speaking about his strategy and overlay, he says, “It’s really designed as a tool for investors to manage their drawdown risks. The idea is during periods of stress, when their portfolios will be experiencing drawdowns and suffering losses, this strategy delivers some gains during those periods. It’s designed to deliver positive performance.”
If an investor wants to use it tactically, to express a view, they can do that because the Top-Down fund has a protective position. The strategy is really to create a return profile, like buying a put option without the same degree of cost. Because buying put options to protect a portfolio, becomes expensive by paying away in premiums.
Coltman says the majority of securities in the portfolio are equity derivatives with a smaller allocation to interest rate, credit and FX derivatives. For example, “we sold some puts on gold to generate premium and we have a section which is long/short where we are buying high quality equities and hedging them with the index. During periods of stress, funding costs become more expensive, credit spreads are widening, higher quality equities tend to outperform the market.”
“We have all of these sub strategies that are rules based. They trade systematically,” says Coltman.
Part of the reason the fund is so diversified, is to ensure strategies work in many environments; inflationary or disinflationary. Using trend following strategies, that will follow a trend such as an inflationary trend, such as short bonds to capture rising rates.
We asked Coltman, how he builds robust diversification across different market regimes?
Coltman says “We aren’t positioning the portfolio for one specific outcome. It’s positioning strategies that can work through many different scenarios. Markets that crash very quickly, benefit from having long volatility but strategies that move more slowly over a protracted period benefit from trend following.”
The fund was up 4.5 percent early March year to date and then the recent rebound has given back some of those gains. The Ukraine crisis has been positive for the strategy, the decline in equities and increase in volatility brings about a positive return.
Investors using the 60/40 investment strategy might be finding that the low yielding bonds in their portfolio, bought to provide negative correlation to equities, have been sold off with equities. Bonds haven’t been providing the diversification benefits as was expected.
Coltman advises investors to use the barbell approach. That is; splitting part of the bond allocation between higher return growth equities and hedging. Investors can use this hedging as protection at a modest cost to mitigate against losses during meaningful drawdowns for global equity markets.